Crook, Fool, or Both
Distinguishes between two types of people in uncertain situations: the fool, who takes risks they don't understand and mistakes luck for skill, and the crook, who transfers risks to others, often through misaligned incentives. The concept extends the Silver Rule: avoid taking advice from paid advisors unless they face penalties for bad advice.
THE IDEA
Crook, Fool, or Both
One practical extension of the Silver Rule (as a reminder, it is the one that says Do not do to others what you don’t want them to do to you):
Avoid taking advice from someone who gives advice for a living, unless there is a penalty for their advice.
Recall the earlier comment on how “I trust you” straddles both ethics and knowledge. There is always an element of fools of randomness and crooks of randomness in matters of uncertainty; one has a lack of understanding, the second has warped incentives. One, the fool, takes risks he doesn’t understand, mistaking his own past luck for skills, the other, the crook, transfers risks to others. Economists, when they talk about skin in the game, are only concerned with the second.
Let us flesh out the idea of agency, well-known and studied by insurance companies. Simply, you know a lot more about your health than any insurer would. So you have an incentive to get an insurance policy when you detect an illness before someone else knows about it. By getting insured when it fits you, not when you are healthy, you end up costing the system more than you put into it, hence causing a raise in premia paid by all sorts of innocent people (including, again, the Spanish grammar specialists). Insurance companies have filters such as high deductibles and other methods to eliminate such imbalances.
The agency problem (or principal-agent problem) also manifests itself in the misalignment of interests in transactions: a vendor in a one-shot transaction does not have his interests aligned to yours—and so can hide stuff from you.
But disincentive is not enough: the fool is a real thing. Some people do not know their own interest—just consider addicts, workaholics, people trapped in a bad relationship, people who support large government, the press, book reviewers, or respectable bureaucrats, all of whom for some mysterious reason act against their own interest. So there is this other instance where filtering plays a role: fools of randomness are purged by reality so they stop harming others. Recall that it is at the foundation of evolution that systems get smart by elimination.
There is another point: we may not know beforehand if an action is foolish—but reality knows.
When to use it
When choosing a financial adviser, examine how they are paid, what conflicts they disclose and what consequences they bear if their advice fails.
When evaluating a mentor's advice, consider if they have relevant experience and if they bear consequences for bad advice (e.g., reputation, financial loss).
In policy-making, examine whether decision-makers bear the costs of poor advice and whether accountability mechanisms protect the people exposed to those costs.
When making personal decisions, actively seek out feedback from diverse sources and consider the possibility that past successes may be due to luck rather than skill.
FROM THEORY TO EVERYDAY LIFE
In practice
Financial Advisor with Skin in the Game
A financial adviser recommends a risky fund and earns a commission while the client bears the investment loss. This creates a potential conflict of interest; it does not by itself establish dishonesty. Investing alongside the client can change the adviser’s incentives, although differences in fees, stakes and ability to bear losses still matter.
Entrepreneur's Luck vs Skill
A startup founder attributes their company's success entirely to their own business acumen, ignoring market tailwinds and a lucky break. They then double down on risky strategies without hedging, convinced of their skill. This is a fool's behavior, as they mistake luck for skill and fail to recognize the role of randomness.
A MOMENT TO REFLECT
Put it to work.
Think of a time you took advice from a professional. Did they have skin in the game? How could you have verified their incentives?
Consider a decision you made that worked out well. Was it truly skill or was luck involved? How can you differentiate between the two in future decisions?
In what situations might you unknowingly act as either the fool (taking hidden risks) or the crook (shifting risks to others)? How could you recognize and correct this?
CONTINUE THE CONVERSATION
Source texts
- Skin In The Game Hidden Asymmetries In Daily Life (Nassim Nicholas Taleb)